Aram, one of the two production managers at Just Face It, was happy that he got his bonus this year but still upset that he didnt get his bonus last year. The company makes 24K gold peel-off face masks, which are holding their own in the market. He was not holding his emotions so well, however, in his conversation with Janessa, the accounting supervisor.

Aram: I worked my team so hard, both years. This year, we increased our yield in order to beat the production quota, while last year we worked hard to follow a lean approach to inventory. It required a lot of extra time scheduling, and still sales were exactly the same in both years. I dont understand. How can we sell the same volume of units for two straight years, incur the same costs, and one year we get a bonus and one year we dont? Please tell me whats going on. Janessa: Calm down, Aram. Let me try to break this down for you. Do you remember our third quarter meeting, when I spoke up about inventory, wondering where we stood and where it looked like we might land in terms of ending inventory? Aram: Yes, vaguely. Why? What does that have to do with anything? Janessa: It has everything to do with the situation we are in. If you recall, we have always used an accounting method called absorption costing. Ive been trying to get our executives to agree to use a different system for bonus calculations, but so far they arent buying it. Here, let me show you something. Janessa used the following information to help her address Arams concerns. She also noted there were no price or efficiency variances in either year. Any fixed-MOH volume variance is written off directly to COGS.

Year 1 Year 2 Beginning FG Inventory 5,000 units Budgeted production 300,000 units 300,000 units Actual production 300,000 units 310,000 units Actual sales volume 305,000 units 305,000 units Selling price $4.00 per unit $4.00 per unit Budgeted variable manufacturing costs $1.80 per unit $1.80 per unit Budgeted variable operating costs $0.50 per unit $0.50 per unit Budgeted fixed manufacturing costs $120,000 $120,000 Budgeted fixed operating costs $195,000 $195,000 Required

1. Prepare the absorption costing income statements that Janessa would have shown Aram for both years (assume beginning FG Inventory cost per unit in Year 1 is the same as the current periods inventory cost per unit under absorption costing). Explain to Aram why income is the same or different in these two years when sales volume is the same. 2. Present the variable costing income statements that Janessa would have shown Aram for both years. Assume beginning FG Inventory cost per unit in Year 1 is the same as the current periods inventory cost per unit under variable costing. Explain to Aram why income is the same or different in these two years when sales volume is the same. 3. Explain to Aram why income is the same or different between variable and absorption costing each year. 4. Janessa is hoping she can talk Aram into helping her press the issue of a different costing system with the executive team. What points would they write down in favor of using absorption costing? What points would they write down in favor of using variable costing? 5. Should management of Just Face It consider using both methods? Explain what additional costs the company would incur if it presents its income statements on a quarterly basis using both absorption and variable costing. Do you believe the benefit of the variable costing information in part (b) is worth this cost? Explain.